Welcome Relief for Certain Loans Made by LPs to Limited Partners

This content was originally published in the Canadian Tax Foundations newsletter: Canadian Tax Focus. Republished with permission.

Until the negative opinion in TI 2016 – 0637341E5 (June 27, 2016), a common method of providing limited partners with access to the partnership’s cash flow from the current fiscal period had been a loan from the partnership, possibly with a repayment after the end of the fiscal period. The CRA has now provided a road map for reviving this strategy (2022 APFF Roundtable (October 2022) and the CTF Annual Conference (November 2022)), but care must be taken to work within the boundaries provided.

A main reason for considering a loan to limited partners has been that a normal distribution of current-year partnership profits could present a timing problem. Generally, a partnership’s income for a fiscal year is added to the ACB of the partnership interest after the fiscal year-end (subparagraph 53(1)(e)(i)). By contrast, a distribution of the partnership profits or capital immediately reduces the ACB of the partnership interest (subparagraph 53(2)(c)(v)) – and if that becomes negative, there would be a deemed capital gain in the same amount to the limited partners (subsections 40(3.1) and 40(3.11)). 

The potential flaw in the loan approach identified in the 2016 TI is that the loan could be considered in lieu of payment of distribution of the partnership profits or capital. In that case, the negative ACB problem is not bypassed by using a loan.

In its latest opinions (noted above), the CRA states that such loan will not be considered to be in lieu of payment of distribution if the following conditions below are met:

1. The loan is not made on account of a withdrawal of a limited partner’s capital contribution.
2. The total amount of all loans received by the limited partner in respect of a fiscal period of the partnership does not exceed the total of the limited partner’s share of the income for the fiscal year and the ACB of the partnership’s interest at the end of the fiscal period.
3. Shortly after the end of the fiscal period, the partnership declares a distribution payable to the limited partner for the same amount, and the distribution is used to settle the loan to the limited partner (in cash or by way of set-off).
4. The purpose of the transaction is to avoid a 40(3.1) deemed gain to the limited partner caused solely by the difference in timing between the addition to ACB for the partnership income and the reduction in ACB related to the distribution.
5. The partnership interest is not a tax shelter, and the transaction is not part of an avoidance transaction to which GAAR will apply. 

Conditions 1 and 2 mean that the amount of the loan must be limited to the sum of the limited partner’s share of the partnership’s current-year income, and any undistributed income for all previous fiscal years that ended before the loan is made. In other words, this is not an opportunity to receive more cash than the limited partner’s share of the partnership profits.  Condition 3 and 4 require that the loan advance be followed by a distribution of the partnership profit shortly after the fiscal year-end to set off the loan advance and that the purpose is to avoid a 40(3.1) gain.  For example, if the partnership defers distribution until late in the next fiscal year, the CRA opinion may not apply.